Reassessing underwriting strategies: protective-value studies can help assess mortality risks as well as value the possible cost of losing good business.

The need to reduce underwriting costs and shorten time to policy issue, while at the same time preserving mortality experience, are challenges faced by direct writing insurers and reinsurers alike. Well designed protective-value studies help us understand how various underwriting strategies are likely to affect mortality and enable all parties to make the best decisions possible.

Traditionally, protective-value studies have considered only the mortality savings that potentially can be identified through various underwriting requirements and ignored the potential cost of losing good business. Typically, an estimate of the mortality risk, usually expressed in terms of debits, is assigned to abnormal test results or the discovery of other information obtained during underwriting. These debits are usually converted into excess deaths and averaged over the policies placed to arrive at some estimate of the mortality savings per $1,000 of insurance. The breakeven point above which the potential mortality savings outweighs the cost of the requirement is then calculated by dividing the cost of the underwriting requirement by the mortality savings. However, unless the cost of the requirement is very high or the yield is very low, some protective value can be demonstrated for almost every underwriting requirement. But do additional testing and more underwriting requirements always mean greater protective value? The answer is a qualified "no."

Sometimes, requiring additional testing or underwriting information actually erodes protective value depending on the accuracy of the requirement or test and the prevalence of the impairment. This is true because, to some degree, every test or requirement is flawed by the inability to detect some individuals who have impairments but whose results remain within the normal or acceptable limits (false negatives) and by the tendency for abnormal results to occur in the absence of disease (false positives).

It is intuitively obvious that protective-value is reduced by false negatives: the higher the false negative rate, the greater the likelihood that individuals with an impairment will escape detection and be charged a premium lower than appropriate for their risk. One remedy for this is to employ more tests or more sensitive tests. However, doing so is likely to increase the number of false positive results.

False positive results may cause applications to be postponed until other additional requirements are met or may otherwise result in adverse actions being taken--both outcomes tend to cause some applicants who would otherwise present good risks to take their business elsewhere, resulting in good business lost. Although the cost of losing good business is more difficult to quantify than are the costs associated directly or indirectly with underwriting requirements, it is no less real and no less important.

Having said this, the mortality savings derived from most underwriting requirements usually far outweigh requirement costs. For example, researchers such as Mihelic, Tak and Rullestad have found that stress tests have significant protective value at relatively low face amounts among persons at risk for coronary disease, including smokers, men, and older individuals, even after accounting for false positive results (Journal of Insurance Medicine 2002).

Companies also should consider how changing their underwriting requirements might influence the risk of antiselection and how antiselection may change the frequency of an impairment among those applying for insurance. If a company's age and amount requirements relative to a particular impairment are substantially more liberal than those commonly found in the marketplace, more individuals with that impairment might be expected to apply to that company. This would increase the pretest probability of the impairment and consequently increase the protective value derived from changes to the underwriting requirements tailored to detect that impairment. In addition, if the pretest probability of the impairment is high, the risk of false-positive test results and the cost of losing good business would be expected to be relatively low.

However, the cost may become significant if either the pretest likelihood of the impairment is low and/or the false positive rate is high. Companies should evaluate carefully not only the mortality savings, but also the potential for the cost of lost good business when considering whether to employ existing underwriting requirements in different populations or add new underwriting requirements, whether that be new lab tests or other underwriting requirements such as credit and pharmacy database queries.

By incorporating the false-positive result rates into protective-value calculations, a more accurate measure of the "net protective value" of a requirement may be derived, which reflects not only the mortality savings attributable to a requirement but also which includes the potential cost of good business lost.

Dr. Martin Engman, a Best's Review columnist, is vice president, research and senior medical director for ING Re's Individual Life and Health Operation based in Denver. He may be reached at [e-mail].